Fundamental vs. Technical VC Investing

Eric Wiesen

Public market equity investors typically fall into one of two camps: Fundamental or Technical Analysis. Sure, many combine both, but most are essentially one or the other.

At a high level, fundamental investors look at the underlying business to determine how well it will perform. They look at margin expansion or contraction, performance of suppliers and customers and new market opportunities. They meet with management and assess their ability to execute the company’s strategy.

Technical investors, by contrast, are much more focused on the movement of securities within the market, and have developed a whole science around price movement, volatility, volume, etc… They look at “support levels” and patterns in time series charts. They are essentially trying to quantify the psychology of the liquid market to predict what the mass of other investors are likely to do.

Put in a simple way, fundamental investors buy the business. Technical investors buy (or sell short) the stock.

So what does this have to do with VC investing? There are no liquid markets, so everyone is a fundamental investor, right? I would argue no – that there is a type of thinking among VCs that is analogous to technical analysis, and that some measure of a VC’s decision-making process is usually contingent on this process.

The basic evaluation model here at RRE (and I suspect at most VC firms) is often described on this blog: Market/People/Technology. It’s relatively straightforward – is a given company led by great entrepreneurs, targeting a big opportunity in a defensible way? This is the fundamental analysis we perform, and it generally drives our yay or nay decision on companies we see. Is this (or is it likely to be) a good business? But once we’ve gotten comfort on these first-order questions, we then ask another set of questions:

• Who are the company’s comparables, be they startups or public companies?
• How do the markets value those companies?
• What success stories can we find of companies taking a similar approach to the one we’re looking at?
• Who are the likely buyers for this company? What multiple of revenues or EBITDA do those companies enjoy in the market? How acquisitive have they historically been?

These aren’t questions about the business itself. They don’t speak to whether the company has good leadership, whether its customers will want its product or whether its business model makes sense. These are market attitude and structure questions. They poll, to the extent that we can, the psychology and appetite in the market for this type of company.

Ultimately, this is the technical analysis piece of VC investing, and often is a part of the pitch process that entrepreneurs don’t expect. While there aren’t head-and-shoulders or cup-and-handle charts, it’s the part of the evaluation that gets done more on the position of the company as a tradable asset rather than as an underlying business. How will it be valued, and when, and by whom?

The approach to this piece of the analysis varies from investor to investor. Some will ask the entrepreneur straight out, “Who buys this business?” to see how the she thinks about the exit opportunities. Others don’t consider this a part of the process, but will think about it internally. Personally, I like to have this dialog with founders, to see if they are thinking early on about the exit trajectory the business could take, even though we usually agree we’ll have very limited visibility at an early stage. It’s more process and attitude than anything else.

Ultimately, you can see evidence of firms who prioritize the technical piece more than others. When you see VC “momentum investing” in a sector – consistent funding of a dozen or more ad networks, for example, it is at least partially the result of investors looking at the market, seeing the big exits and robust valuations and wanting to make a bet in a market that’s clearly in favor. This is the VC flavor of technical analysis.

Generally speaking, this element is something we do at RRE, but it’s second-order for us. To put it another way, we will not make a bet purely on momentum and analogous big outcomes, but it will help inform a decision about a business we like. If the fundamental analysis comes back strong, but the technical piece looks very bad (public comps are valued very low, previous exits in the space have been at 1X revenues) it will admittedly give us pause. Because ultimately we need to see an opportunity to return a multiple of capital to our limited partners, and if the market isn’t interested in a deal we do, that is going to matter.